Wednesday, August 17, 2011

Economist Chris Thornberg with Beacon Economics told me he was working on a piece about the recent volatility in the stock market, and I think his latest post on No Nonsense Economics is a definite must-read. If you believe, as I do, that Chris' great talent is distilling complex economic issues into plain English -- whether during a speech or in a written essay -- I think he hits of a lot of reasons for this recent volatility right on the head.

Some excerpts:

Was the downgrade unprecedented? Absolutely. Logical? Absolutely not. A bond rating is an estimate of the chance that the borrower will not pay back their debt fully and on time. To justify a downgrade, one has to show why the probability of default has increased. Has the chance of a US default increased in recent months?

As for the amount of debt itself, despite the budget battles and ongoing gap between revenues and expenditures, overall net U.S. debt is still quite low for developed nations—somewhere on the order of 68% of current GDP once the holdings by the Social Security Administration are factored out. Given low interest rates, the current cost of servicing the nation’s existing debt is less than 10% of all expenditures. There is clearly no threat of a default in the near term, even if the debt ceiling had not been raised...

Another long terms issue is the underfunding of the major social insurance programs, particularly Social Security and Medicare/Medicaid. Are they underfunded? Absolutely. But as bad as these problems are, keep in mind that this only becomes a worry if one presumes that at some point in the future the U.S. government will forego payments on existing debt in order to fund current expenditures in these programs. But such a choice won’t be made for 10 or 15 years. Its hard to see anything that has occurred in recent months would have a reasonable impact on the assessment of such choices in the future...

The slow growth in the first quarter was largely due to an unusual pullback in spending on national defense and non-residential structures—spending that bounced back in the second quarter. July’s employment report was more positive, and since then initial claims for unemployment insurance have actually fallen. The primary driver of weak consumer spending in the second quarter has also been removed: Oil prices have fallen sharply—particularly since the stock market began to fall so rapidly. And Japanese cars are again starting to move into the market. Even the housing market—the source of bad news earlier in the year—is starting to show mild signs of life. Prices have risen a bit, as have permits for new residential construction...

While the problems in many European nations are profound, only Greece and Ireland have truly been pushed to the brink of default. In Greece’s case, it is due to years of bad government. They hid the rapid pace of debt accumulation through various nefarious accounting manipulations. The economy is stagnant and uncompetitive, driven there by massive government interference as well as one of the worst corruption problems in Europe. And there is their fundamental inability to raise revenues in a nation famed for its tax avoidance. As for Ireland, none of these factors are in place. There it is only because the government agreed to use public funds to prevent the collapse of the large Irish banks. That had become so heavily involved in the property bubbles in the US and UK.

As for Spain, Portugal, and Italy there are serious problems—but none of these nations is anywhere close to the brink of default. Spain and Portugal have relatively low levels of debt relative to their GDP. Italy has a huge amount of debt, but its economy is stronger than it looks on the surface—and it has a history of being able to handle such crises at the last moment...